Markets surge to record highs as Fed fears ease

Thoughts

• Equity markets begin the week at a record high, as the S&P 500® Index followed the worst week since February with the best week since February. Perceived Fed hawkishness drove the previous week’s decline, while a heavy dose of Fedspeak last week calmed investors’ fears of imminent action. This was reinforced by the Fed’s balance sheet posting its largest weekly increase ($200 billion) in over a year. Through the last full week in June, the S&P 500 has gained 2%, while the Russell 1000 Growth Index has led with a 5% rally, while the MSCI EAFE Index is the laggard with a 1% decline.
• The ample liquidity in the system has driven demand for risk assets. With three trading days remaining in the second quarter, the S&P 500 and S&P Goldman Sachs Commodity Index are both on pace for their fifth-straight 5% quarterly gain for the first time in at least 50 years. Flows into equity funds have accelerated, and investors are increasingly operating with a “buy-the-dip” mentality, with heavy flows into equities last week. Despite the unprecedented challenges, U.S. households added a record $13.5 billion in wealth last year, compared with the last recession in 2008 which saw an $8 trillion decline.
• The path of least resistance for equities is higher given the continued fiscal and monetary support.

News

• Infrastructure deal negotiations are back on track after President Biden walked back comments that he would veto the proposal if lawmakers failed to pass a separate domestic spending agenda favored by Democrats. A group of 11 Republican and 10 Democrat senators support the deal that adds $579 billion in infrastructure spending on roads, bridges, airports, broadband, water, and electric vehicles. The broader domestic spending bill will quickly follow, with hopes for a price tag around $4 trillion on a partisan basis through reconciliation. Swing voter Senator Manchin noted he could support a hike in the corporate tax rate to 25% from 21%, but not the original proposal of 28% as a funding vehicle.
• Inflation data continues to run hotter than expected, with the PCE deflator up 3.9% from a year ago. The core PCE deflator (inflation metric preferred by the Fed) was 3.4%, in line with consensus, but the highest reading since 1992. Earlier in the week, Chair Powell said, “We will not raise interest rates pre-emptively because we fear the possible onset of inflation. We will wait for evidence of actual inflation or other imbalances.” The CEO of the National Association of Manufacturers warned of rising cost pressures, supply chain bottlenecks, worker shortages, and demand exceeding supply in many areas. The next several months will tell the story of whether the period of elevated inflation is transitory. Personal spending was flat from April, below the estimate of 0.4%, while personal spending fell a better-than-expected 2.0%, though both numbers have recently been distorted by government stimulus checks.
• With a week remaining in the month, attention will soon shift towards second-quarter earnings season. Current estimates show growth of 62%, better than the 52% estimate at the beginning of the quarter. The strong macro environment provides the potential for upside to that estimate. Credit Suisse notes that while economic estimates suggest 18% revenue growth, consensus is for 12% growth. Similarly, UBS notes that earnings are expected to drop 7% versus the first quarter, while sequential GDP growth is over 10% annualized.

What to Watch

• Markets could be volatile this week as institutional investors position around quarter-end. Economic data include consumer confidence on Tuesday, pending home sales on Wednesday, ISM manufacturing data on Thursday, and durable goods and the closely watched monthly payroll report on Friday. OPEC+ meets on Thursday to discuss boosting production.